Week Three Problem Set
Week Three Problem Set
Determining whether income is included or excluded from gross income takes into account the all-inclusive definition of income, which specifies all income is included from whatever source derived unless a tax provision indicates otherwise (Spilker, et al., 2010). Once gross income has been determined, deductions directly and indirectly related to business activities, and deductions subsidizing specific activities are analyzed to calculate adjusted gross income (AGI). Such deductions are commonly referred to as for AGI deductions. To reach the next important reference point in the tax formula, taxpayers reduce their AGI by deductions from AGI to determine taxable income. The following comprehensive problems depict transactions effecting gross income, adjusted gross income, and taxable business income for three separate taxpayer groups.
Comprehensive Problem 67 (Ch. 5)
Ken is a single taxpayer and although retired, he is still very active. His reported financial information was used in determining his 2009 gross income, which was calculated as $58,000. Relevant information related to each reported transaction is as follows:
a) Gross income includes income from all sources; both legal and illegal. Therefore, Ken’s $1,200 gain from the illegal game of poker is included as a component of gross income.
b) Consistent with the return of capital principle, taxpayers are allowed to recover their tax basis before realizing any gain when disposing of an asset. Thus, Ken’s gain from selling 1,000 shares of stocks is $1,000 as depicted in Table 1:
Kens Stock Sale
Sales proceeds ($32 x 1,000 shares)
$32,000
Less: Tax basis (investment) in property sold ($31 x 1,000 shares)
31,000
Gain (Loss) on sale
$1,000
Table 1. Stock Gain (Loss) Calculation
c) An annuity is an investment type that pays a stream of equal payments over time. The tax law deems a portion of each annuity payment as a nontaxable return of capital and the remainder as gross income (Spilker, et al., 2010). Table 2 depicts Ken’s gross income per annuity payment.
Annuity Income
Description
Amount
Explanation
Investment in annuity contract
$210,000
Number of payments
Return of capital per payment
10,500
(1)/(2)
Amount of each payment
25,000
Gross income per payment
14,500
(4) – (3)
Table 2. Annuity Income Calculation
d) Depending upon the amount